Revise Costing applications for Cambridge 9706 (2.2.1)

Specific order costing is a method used by businesses that produce non-standardised goods or services based on individual customer orders. Unlike mass production, each output is distinct, requiring costs to be traced and allocated to a specific 'cost unit', which could be a single job or a batch of items. The primary objective is to determine the cost and, subsequently, the profitability of each individual order. This involves meticulously tracking direct materials, direct labour, and direct expenses attributable to the order, and then absorbing a fair share of the business's production overheads. Job costing and batch costing are the two principal methods that fall under the umbrella of specific order costing, each suited to different production environments.

Job costing is applied when work is undertaken to a customer's specific requirements, resulting in a unique, non-standard product or service. Each job is treated as a separate cost centre. Examples include construction projects, bespoke furniture making, and professional services like auditing or advertising campaigns. The core document is the 'job cost sheet' or 'job cost card', which acts as a ledger for accumulating all costs associated with a particular job. Direct materials are tracked via materials requisitions, and direct labour is recorded using timesheets. Production overheads are then absorbed into the job cost, typically using a predetermined overhead absorption rate (OAR) based on direct labour hours or machine hours. The total cost on the sheet represents the cost of production for that single job.

Batch costing is a form of specific order costing used when a group of identical or similar items are produced together for a single order or for stock. The 'cost unit' is the batch itself. This method is common in industries like baking (a batch of loaves), printing (a run of 1,000 leaflets), and clothing manufacture (a batch of 500 identical shirts). Costs for materials, labour, and overheads are accumulated for the entire batch, similar to job costing. Once the total cost of the batch is determined, the cost per unit is calculated by dividing the total batch cost by the number of units produced in that batch. This provides an average cost for each item within the group, blending principles of both job and process costing.

Indirect costs, or overheads (like factory rent, supervisor salaries), cannot be directly traced to a single job or batch. Therefore, they must be shared out on a fair basis. This process is called overhead absorption. Businesses calculate a predetermined overhead absorption rate (OAR) at the start of a period.

Formula: OAR = Budgeted Production Overheads / Budgeted Activity Level

The activity level can be direct labour hours, machine hours, or another suitable base. This OAR is then used to charge overheads to each job or batch based on how much of the activity it consumed.

For example, if the OAR is $15 per machine hour, and a job uses 10 machine hours, it will be charged (absorb) $150 of overheads (10 hours × $15/hour).

A key objective of any costing system is to determine the cost per unit, which is fundamental for setting selling prices and measuring profitability. In job costing, the 'unit' is the job itself, so the total job cost is the final figure. In batch costing, the unit cost is found by the formula: Total Batch Cost / Number of Units in Batch. For continuous production of a single product (sometimes called single or output costing), the formula is: Total Production Costs for a Period / Number of Units Produced in the Period. Once the total cost of a job or the unit cost from a batch is known, the business can calculate its profit by subtracting this cost from the selling price or revenue.